Pound sinks to record low against US dollar after UK announces biggest tax cut

Sterling fell to about 1.033 against the greenback on Monday after the UK government said last week increased borrowing would fund the country's biggest tax cuts in five decades

The pound plunged to a record low against the dollar on September 26, 2022. AFP

The British pound fell to a record low against the US dollar in early trading on Monday after UK Chancellor Kwasi Kwarteng said last week the government would fund the country's biggest tax cuts in five decades by increased borrowing.

Sterling fell to about $1.033 in early trading in Asia, before rising again. It was trading at $1.0676 against the greenback at 9.22pm UAE time. The pound has lost more than 20 per cent of its value against the dollar since the start of the year.

"Sterling is getting absolutely pounded [and] looks like an emerging market currency, especially when you look at the price of the British pound a few months ago and compare it to where it is now," said Naeem Aslam, chief market analyst at AvaTrade. He said that the currency could hit parity with the US dollar this week.

On Friday, Mr Kwarteng announced £45 billion ($47.49bn) debt-financed tax cuts that sparked a sell-off in UK government bonds as investors shun fixed-income investments with the inflation rate at a near four-decade high.

"Markets firmly rejected the plans with the collapse in sterling the most notable move, but borrowing costs for the British government also surged," said Edward Bell, a senior director of market economics at Emirates NBD.

The yield on the two-year UK government bond jumped 44 basis points at the end of last week to 3.983 per cent, while the yield on the five-year UK government bond jumped more than 50bps to 4.043 per cent and the 10 year gained 33 bps to 3.82 per cent.

"Should the government announce even more accommodative fiscal policy, the sell-off in British assets, particularly the pound and bonds, could unwind in an even more disorderly manner," Mr Bell said.

Mr Kwarteng announced the government's mini-budget a day after the Bank of England increased interest rates by 50 basis points. This was the second consecutive 50-point rate increase.

“Attempting to prevent inflation from becoming broad-based, the BoE hiked its policy rate to 2.25 per cent, a new 14-year high, despite acknowledging that the UK is in a recession,” said David Alexander Meier in the economic research division of Swiss bank Julius Baer.

The BoE acknowledged that the UK is now in a recession, expecting a 0.1 per cent drop in gross domestic product in the third quarter caused by slowing consumer spending and weaker economic activity.

Annual inflation in August reached 9.9 per cent, the Office for National Statistics said earlier this month. This was slower than the 10.1 per cent registered in July, which marked a four-decade high, but is still above the BoE's 2 per cent target rate.

The BoE raised its rate a day after the US Federal Reserve implemented its third 75 point rate increase in a row, which prompted central banks around the world to raise rates.

The Bank of England Governor Andrew Bailey said on Monday that the BoE “will not hesitate” to raise interest rates if needed to meet its 2 per cent inflation target.

“The bank is monitoring developments in financial markets very closely in light of the significant repricing of financial assets,” he said in a statement.

“The role of monetary policy is to ensure that demand does not get ahead of supply in a way that leads to more inflation over the medium term.”